Puerto Rico is $72+billion in debt, and defaulted last month on a $422 million debt payment for the third time. Governor Alejandro García Padilla calls it “a humanitarian crisis,” continues to spend like crazy, wants Washington to bail him out, and won’t act to reduce the size of government, the cost of energy, or the cost of doing business in the island.

Failure to negotiate in good faith could cost the island the help it seeks from Washington.

On Sept. 1 the state-owned Puerto Rico Electric Power Authority (Prepa) faces a deadline for restructuring more than $8 billion in debt. If it can’t come to an agreement with creditors, a previous forbearance agreement will expire and the company will face default.

On Sept. 1 the state-owned Puerto Rico Electric Power Authority (Prepa) faces a deadline for restructuring more than $8 billion in debt. If it can’t come to an agreement with creditors, a previous forbearance agreement will expire and the company will face default.

In that event, bondholders could be expected to go to court to begin the process of receivership, as the bond contracts stipulate.

This high-stakes negotiation comes when Puerto Rico is asking Congress to give its municipalities and public agencies access to the chapter 9 bankruptcy protection the 50 states have. A Prepa default would be disruptive and possibly increase the odds that Congress will agree.

But failure on the part of the utility to negotiate in good faith also could backfire and jeopardize support in Washington for giving Puerto Rico chapter 9 protection. It could also reduce sympathy on the mainland for the write-down of other Puerto Rico debt issues—which total some $63 billion—that Gov. Alejandro García Padilla says he needs to get the island growing again.

Read the whole article.

The thing is, the governor has little to lose by defaulting.

I have stated in the past that you can be assured the Puerto Rican government will continue to spend like crazy because 20% of the workforce is in government jobs, which gives the ruling party a built-in constituency. As I have pointed out before, it’s in the governor’s best interest to keep them happy, even if it means to default on all debt in order to meet payroll.

If the U.S. refills the ATM, García Padilla will claim credit for it; if the U.S. doesn’t, he has someone to blame.

People who don’t agree with the economic policy are exercising their right to move to places where the U.S. economy is brighter, thereby removing a large number of what would be opposition votes.

High debt-high spending make the island less appealing for statehood status.

The commonwealth paid a mere $628,000 toward a $58 million debt bill due Monday to creditors of its Public Finance Corporation. This will hurt the island’s residents, not Wall Street. The debt is mostly owned by ordinary Puerto Ricans through credit unions.

And (emphasis added)

On Monday, Puerto Rico had to make a monthly debt payment of $483 million. Puerto Rico paid all its debt due except the $58 million due to creditors of its Public Finance Corporation. The government is strategically choosing not to pay the PFC debt because the entities that own the debt, credit unions and ordinary Puerto Ricans, have little legal power to fight back in court.

The PFC’s 99% missed instalment [sic] is unlikely to set off an immediate cascade of lawsuits or further defaults. Its paper is technically nothing more than a “moral obligation”, backed only by a flimsy letter of credit from the Government Development Bank (GDB), and is mostly held by pliant local investors like credit unions. Just three days before the PFC stiffed its lenders, the GDB duly made a $170m payment on its own debt. Nonetheless, the PFC’s default sharply accelerates Puerto Rico’s debt crisis: it extinguishes any hope that the island’s creditors might all emerge unscathed, and cuts off whatever access to short-term financing the government might have had left.

It may well have been Mr García Padilla’s intention to provoke a sense of urgency.. . .After the island passed its own version of Chapter Nine last year, federal courts struck it down, on the grounds that municipal bankruptcy falls exclusively under federal jurisdiction. That left the governor with no choice but to beseech America’s Congress to bring his territory under Chapter Nine, a plea that has so far fallen on deaf ears. By letting the weakest link in its payment chain snap, Puerto Rico has made the spectre of a chaotic, piecemeal default—which once seemed remote—immediate. In theory, that could spur Congress into taking swift action.

Even if the ploy of taking-oneself-hostage were to succeed, however, the extension of Chapter Nine to America’s overseas territories would not be a cure-all. That law would not cover the restructuring of Puerto Rico’s $13 billion of “general-obligation” (GO) debt, which is protected by a constitutional pledge that it must be paid before all other obligations,

“The government is strategically choosing not to pay the PFC debt because the entities that own the debt, credit unions and ordinary Puerto Ricans, have little legal power to fight back in court.”

They ran out of their own people’s money, but you can be assured they will continue to spend like crazy because 20% of the workforce is on government jobs, which gives the ruling party a built-in constituency. As I have pointed out before, it’s in the governor’s best interest to keep those happy, even if it means to default on all debt in order to meet payroll.

and includes the staggering failure to adequately account for revenues and expenditures

which points to serious structural problems the current governor, Alejandro García Padilla, is not addressing, asking instead bondholders to “share the sacrifices.”

Here’s the situation as I see it:

It is not in García Padilla’s interest to improve the economy

García Padilla’s administration relies heavily on a large bureaucracy, and he knows his predecessor was voted out of office for trying to reduce it. Estimates show that the government of Puerto Rico has 160,000 employees too many. That’s enough of a voter base to keep him in office.

If the U.S. refills the ATM, García Padilla will claim credit for it; if the U.S. doesn’t, he has someone to blame.

And don’t forget that García Padilla and other commonwealth supporters lost miserably during the last plebiscite, when statehood won by approx. 60%. For as long as Puerto Rico remains in a financial swamp, García Padilla knows the question of statehood will be dismissed with “And They Want to Be a State?”
(Or as Ed Koch put it, “The People have spoken … and they must be punished.”)

A group of institutional bondholders—including Franklin Advisors and Oppenheimer Funds—representing 40% of the outstanding bonds and more than 500,000 individual bondholders have offered the company a restructuring plan to avoid receivership. It includes a new, $2 billion capital commitment to modernize power-generation equipment and cut costs. If Prepa [Puerto Rico Electric Power Authority (Prepa)] can improve its operational efficiency, the group believes that its proposal can lower the electricity rate to the range of 22 cents per kilowatt-hour from the 28-cent range of recent years.

This intervention is unlikely to appeal to Puerto Rico’s political class, which uses Prepa as a populist honey pot. The company has a dismal collection record and one of the most notorious deadbeats is the government. A Nov. 15, 2014, report by FTI Capital Advisors found that the company had “over $200 million in accounts receivable from public corporations, of which approximately 70% is over 120 days old.”

Making them pay is the right thing to do; it’s just not the Puerto Rican thing to do.

A Puerto Rican default should not surprise anyone. According to Carlos Colón de Armas, acting dean of the School of Business Administration at the University of Puerto Rico, for eight years from 2005 through 2012, government expenses exceeded revenues on average by approximately $1 billion annually. The dean told me by telephone that total commonwealth debt is now around $73 billion and in 2013 it was 101% of the island’s gross national product (GNP) up from 57% in June 2001. (Although gross domestic product is the most widely accepted measure of an economy’s size, it reflects the profits of large multinational corporations booked for tax purposes in Puerto Rico but not retained in the local economy. Therefore, GNP, a measure of what is produced by locals, is a more accurate tool to assess the economy.)

increased expenses by almost $600 million in his first budget. While he is now cutting spending, the cuts are mostly from that increase, according to Mr. Colón de Armas. Some $500 million-$800 million in fat—from subsidies to special interests to funding for political parties—remains untouched in the $9.6 billion budget.

Fortuño lost by 12,000 votes since García Padilla (known as Agapito) promised the moon and the stars.

Too much bureaucracy, much of it for welfare, and too much rewarding failure over success drive up costs and drive out the productive. Puerto Rico’s most talented citizens are voting with their feet. The island loses about 1% of its population a year, a deadly loss compounded over the years for any economy.
To bring these people back, the governor has to fight to cut taxes and really go after the country’s entrenched special interests with a baseball bat.

The 39% corporate tax has to go.

He [governor Alejandro García Padilla] also must fight in the U.S. Congress to reinstate Puerto Rico’s special tax break that ended in 2006 so that investment will once again return.

Finally, he must also take on Big Labor’s favorite, the Jones Act, which artificially drives up shipping costs, putting local manufacturers at a disadvantage, demanding Congress at least give Puerto Rico an exception.

S&P on Tuesday lowered Puerto Rico’s general obligation bond rating to double-B-plus from triple-B-minus, stripping the island of its investment grade rating. The rating firm said it cut the rating because of Puerto Rico’s “reduced capacity” to borrow and the contraction in its economy in all but one year since 2006. It kept the island’s ratings on watch and warned of further cuts if the island is unable to raise money.

Puerto Rico has also been weighed down by large pension obligations, a 15% unemployment rate and big losses in the value of some of its debt. But the Puerto Rico government has been taking steps to bolster the economy and improve its fiscal outlook by overhauling pensions and raising taxes.

Despite the benign response to the downgrade, the cut adds pressure on Puerto Rico to shore up its finances with a near-term borrowing, analysts said. Puerto Rico, which has $70 billion of debt, has been able to put off borrowing in recent months, but its flexibility is fading, said Daniel Hanson, a credit analyst at Height Securities LLC.

Island officials have been planning a bond offering of some $2 billion in coming weeks, according to people familiar with the matter. The officials have been weighing how to raise money with offerings backed by sales taxes or the island’s general fund, or a deal structured by hedge funds and other distressed investors who may demand yields near 10%.

Gov. Alejandro García Padilla is finally trying to cut the budget and reduce the deficit to $75 million, something he’s been avoiding, considering how his predecessor, Luis Fortuño, was not re-elected for doing just that.